New tax law affects divorce settlements

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Dreamstime

Elliot Raphaelson, Tribune Content AgencyThe Savings Game

The Tax Cuts and Job Act changed the rules regarding tax deductions for both parties in divorce and separation agreements, starting in 2019. Divorce agreements executed before 2019 will not be affected. Under the new tax law, alimony payments will not be tax-deductible. Alimony will be tax-free to recipients.

The new tax law may increase the value of tax-deferred retirement savings not paid in cash in divorce negotiations. This would include property, common stock, real estate, retirement plans such as a 401(k) under a qualified domestic relations order and balances from an IRA (subject to state law limitations).

Taxable alimony may be used to fund IRAs because it is considered compensation, but tax-free alimony does not qualify as compensation and can't be used to fund an IRA. Accordingly, a recipient receiving cash as alimony after 2019 may not use it fund an IRA.

However, there will be opportunities to use non-cash transfers to benefit both parties in divorce agreements. For example, assume an individual in the 35 percent tax bracket transfers part of a retirement plan, such as an IRA or 401(k), to a recipient in the 25 percent tax bracket. The recipient receives the transfer tax-free. The donor does not pay any taxes on the distribution. The recipient would be paying a lower tax on any withdrawals. There is a disadvantage for the recipient is when he/she is younger than 59 1/2: There would be a 10 percent early retirement penalty.

After 2019, divorce attorneys will have to be more creative in structuring divorce agreements to satisfy both the donor and the recipient.

For individuals either contemplating divorce or already divorced, it is important to understand Social Security regulations. For example, if you are considering a divorce and the marriage has lasted close to but less than 10 years, it is advantageous to maintain the marriage for at least 10 years. Otherwise, you will not be eligible for any spousal Social Security benefits, including widow(er) benefits.

If you are divorced and are considering re-marriage, you should understand that individuals who do remarry are not eligible for some Social Security divorce-related benefits. If you remarry after age 60, you will be entitled to some benefits you otherwise would not be entitled to. For example, you are entitled to widow(er) benefits only if you are currently unmarried or remarried after 60. Even if your ex remarries, you may still be entitled to Social Security benefits. If your ex predeceases you, you may be entitled a larger benefit than you were entitled to as an ex-spouse. You should become familiar with the Social Security regulations related to divorce.

I recently read two excellent books about divorce written from different perspectives, one for women and one for men. The titles are "Soon-To Be-Ex: A Woman's Guide to Her Perfect Divorce and Relaunch" and "Soon-To-Be-Ex for Men: Preserving Wealth, Fatherhood, and Sanity during Divorce," written by Jacqueline Newman, an experienced matrimonial lawyer based in New York. (Both are available from www.bookpublishersnetwork.com. You can contact her law firm at www.Berkbot.com.)

The books cover all aspects of divorce. She begins by asking an important question: "Are you sure you want to get divorced?" Assuming you do, she then discusses the three divorce processes -- mediation, collaborative law and litigation -- and the pros and cons of each. For example, mediation is generally the least expensive process and can be the quickest, and parties make the decisions, not attorneys. This process will not work for everyone, and Newman discusses under what circumstances it can work.

She also discusses collaborative law, which involves a team of trained specialists. This process is generally more expensive than mediation, but not as expensive as litigation. You can refer to www.nycollaborativeprofessionals.org for more information concerning collaborative law.